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Option-Implied variance asymmetry and the cross-section of stock returns

Tao Huang and Junye Li

Journal of Banking & Finance, 2019, vol. 101, issue C, 21-36

Abstract: We find a positive relationship between individual stocks’ implied variance asymmetry, defined as the difference between upside and downside risk-neutral semivariances extracted from out-of-money options, and future stock returns. The high-minus-low hedge portfolio earns the excess return of 0.90% (0.67%) per month in equal-weighted (value-weighted) returns. We show that implied variance asymmetry provides a neat measure of risk-neutral skewness and outperforms the standard risk-neutral skewness in predicting the cross-section of future stock returns. Risk-based equilibrium asset pricing models can not explain such a positive relationship, which instead can be potentially explained by information asymmetry and informed trading.

Keywords: Risk-neutral semivariances; Implied variance asymmetry; Risk-neutral skewness; Return predictability; Informed trading; Liquidity (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 (search for similar items in EconPapers)
Date: 2019
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Handle: RePEc:eee:jbfina:v:101:y:2019:i:c:p:21-36